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TOWN SPORTS INTERNATIONAL HOLDINGS INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations
[July 31, 2014]

TOWN SPORTS INTERNATIONAL HOLDINGS INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations


(Edgar Glimpses Via Acquire Media NewsEdge) Introduction In this Form 10-Q, unless otherwise stated or the context otherwise indicates, references to "Town Sports," "TSI," "the Company," "we," "our" and similar references refer to Town Sports International Holdings, Inc. and its subsidiaries, references to "TSI Holdings" refers to Towns Sports International Holdings, Inc., and references to "TSI, LLC" refer to Town Sports International, LLC, our wholly-owned operating subsidiary.



Based on the number of clubs, we are one of the leading owners and operators of fitness clubs in the Northeast and Mid-Atlantic regions of the United States and one of the largest fitness club owners and operators in the United States. As of June 30, 2014, the Company, through its subsidiaries, operated 163 fitness clubs. Our clubs collectively served approximately 488,000 members, including approximately 44,000 members under our restricted student and teacher memberships as of June 30, 2014. We owned and operated a total of 109 clubs under the "New York Sports Clubs" brand name within a 120-mile radius of New York City as of June 30, 2014, including 37 locations in Manhattan where we are the largest fitness club owner and operator. We owned and operated 29 clubs in the Boston region under our "Boston Sports Clubs" brand name, 16 clubs (two of which are partly-owned) in the Washington, D.C. region under our "Washington Sports Clubs" brand name and six clubs in the Philadelphia region under our "Philadelphia Sports Clubs" brand name as of June 30, 2014. In addition, we owned and operated three clubs in Switzerland as of June 30, 2014. We employ localized brand names for our clubs to create an image and atmosphere consistent with the local community and to foster recognition as a local network of quality fitness clubs rather than a national chain.

We develop clusters of clubs to serve densely populated major metropolitan regions and we service such populations by clustering clubs near the highest concentrations of our target customers' areas of both employment and residence.


Our clubs are located for maximum convenience to our members in urban or suburban areas, close to transportation hubs or office or retail centers. Our members include a wide age demographic covering the student market to the active mature market. Our members generally have annual income levels of between $50,000 and $150,000. We believe that this "mid-value" segment is the broadest of the market. Our goal is to be the most recognized health club network in each of the four major metropolitan regions that we serve. We believe that our strategy of clustering clubs provides significant benefits to our members and allows us to achieve strategic operating advantages. In each of our markets, we have developed clusters by initially opening or acquiring clubs located in the more central urban markets of the region and then branching out from these urban centers to suburbs and neighboring communities.

As the fitness industry continues to see a rise in popularity of private studio offerings, we have used our extensive industry experience to offer our own private studio brand, BFX Studio, with our first unit soft opening in July 2014.

This three-dimension luxury studio brand takes advantage of the rise in consumer demand for studio experiences. BFX Studio includes three unique offerings: Ride Republic, which is indoor cycling, Private Sessions for personal training and Master Class for certain group exercise classes. BFX Studio is staffed with high caliber instructors in each of the three core offerings and the studios are designed to appeal to all ages and all experience levels of metropolitan, active healthy lifestylers. This studio concept requires approximately 7,500 to 10,000 square feet of space per studio which compares to the approximately 26,000 square feet aggregate average size of our traditional clubs.

We plan to revise the pricing and marketing strategy for some of our suburban clubs. We believe this will improve results at the respective locations and increase market share for our brands. Memberships at these clubs will be offered at a reduced price and advertising spend will be increased in this model. We currently target approximately 20 of our existing clubs for conversion over the remainder of 2014.

We also reviewed our club portfolio and established plans to close approximately 5% of our clubs, which we believe are lower performing, by the end of 2014, in an effort to consolidate a portion of these members into other existing clubs.

We are expecting costs related to these club closures throughout the remainder of 2014.

Revenue and operating expenses We have two principal sources of revenue: • Membership revenue: Our largest sources of revenue are dues inclusive of maintenance fees and joining fees paid by our members. In addition, we collect usage fees on a per visit basis subject to peak and off-peak hourly restrictions depending on membership type. These dues and fees comprised 78.7% of our total revenue for the six months ended June 30, 2014. We recognize revenue from membership dues in the month when the services are rendered. Approximately 96% of our members pay their monthly dues by Electronic Funds Transfer, or EFT, while the balance is paid annually in advance. We recognize revenue from joining fees over the estimated average membership life.

17 -------------------------------------------------------------------------------- Table of Contents • Ancillary club revenue: For the six months ended June 30, 2014, we generated 15.2% of our revenue from personal training and 4.8% of our revenue from other ancillary programs and services consisting of programming for children, signature classes, Small Group Training and other member activities, as well as sales of miscellaneous sports products. We continue to grow ancillary club revenue by building on ancillary programs such as our personal training membership product and our fee-based Small Group Training programs.

We also receive revenue (approximately 1.3% of our total revenue for the six months ended June 30, 2014) from the rental of space in our facilities to operators who offer wellness-related offerings, such as physical therapy and juice bars. In addition, we sell in-club advertising and sponsorships and generate management fees from certain club facilities that we do not wholly own.

We also collect laundry related revenue for the laundering of towels for third parties. We refer to these revenues as fees and other revenue.

We currently own our 151 East 86th Street, New York location, which houses our New York Sports Clubs on East 86th Street, New York as well as a retail tenant that generates rental income for us. We have entered into an Agreement of Sale (the "Sale Agreement") to sell this property for a purchase price of $85.5 million on or before September 11, 2014. Upon completion of the sale, we will no longer be entitled to the rental income from this retail tenant. Rental income from this retail tenant was approximately $984,000 for each of the six month periods ended June 30, 2014 and 2013. The terms of Sale Agreement, as amended, provide that in the event that the purchaser defaults in its obligations to close, we retain a $20.0 million deposit. As of June 30, 2014, we have received $5.0 million of this deposit which is included in Other current liabilities in the accompanying condensed consolidated balance sheets. In July 2014, we received another $5.0 million of this deposit. The remaining $10.0 million of this deposit is held in escrow.

Our performance is dependent on our ability to continually attract and retain members at our clubs. We experience attrition at our clubs and must attract new members in order to maintain our membership and revenue levels. In the three months ended June 30, 2014 and 2013, our monthly average attrition rate was 3.4% and 3.3%, respectively.

Our operating and selling expenses are comprised of both fixed and variable costs. Fixed costs include club and supervisory and other salary and related expenses, occupancy costs, including most elements of rent, utilities, housekeeping and contracted maintenance expenses, as well as depreciation.

Variable costs are primarily related to payroll associated with ancillary club revenue, membership sales compensation, advertising, certain facility repairs and club supplies.

General and administrative expenses include costs relating to our centralized support functions, such as accounting, insurance, information and communication systems, purchasing, member relations, legal and consulting fees and real estate development expenses. Payroll and related expenses are included in a separate line item on the condensed consolidated statements of operations and are not included in general and administrative expenses.

As clubs mature and increase their membership base, fixed costs are typically spread over an increasing revenue base and operating margins tend to improve.

Conversely, when our membership base declines, our operating margins are negatively impacted.

As of June 30, 2014, 161 of our existing fitness clubs were wholly-owned by us and our condensed consolidated financial statements include the operating results of all such clubs. Two locations in Washington, D.C. were partly-owned and operated by us, with our profit sharing percentages approximating 20% (after priority distributions) and 45%, respectively, and are treated as unconsolidated affiliates for which we apply the equity method of accounting. In addition, we provide management services at locations where we do not have an equity interest which include three fitness clubs located in colleges and universities, four managed sites acquired in connection with our Fitcorp acquisition in May 2013 and one managed site added during the fourth quarter of 2013.

18-------------------------------------------------------------------------------- Table of Contents Historical Club Count The following table sets forth the changes in our club count during each of the quarters in 2013, the full-year 2013, as well as the first and second quarters of 2014.

2013 2014 Full- Q1 Q2 Q3 Q4 Year Q1 Q2 Wholly owned clubs operated at beginning of period 158 157 162 160 158 160 160 New clubs opened - - - - - - 1 Acquired clubs 1 5 - - 6 - - Clubs closed, relocated or merged (2 ) - (2 ) - (4 ) - - Wholly owned clubs at end of period 157 162 160 160 160 160 161 Total clubs operated at end of period (1) 159 164 162 162 162 162 163 (1) Includes wholly-owned and partly-owned clubs. Locations that are managed by us in which we do not have an equity interest are not included in the club count. These managed sites include three managed university locations and four additional managed locations acquired in May 2013 as part of the Fitcorp acquisition as well as one managed location added during the fourth quarter of 2013.

Comparable Club Revenue We define comparable club revenue as revenue at those clubs that were operated by us for over 12 months and comparable club revenue increase (decrease) as revenue for the 13th month and thereafter as applicable as compared to the same period of the prior year.

Key determinants of the comparable club revenue increases (decreases) shown in the table below are new memberships, member retention rates, pricing and ancillary revenue increases (decreases).

2013 Three months ended March 31, 2013 (2.4 )% Three months ended June 30, 2013 (1.7 )% Three months ended September 30, 2013 (1.7 )% Three months ended December 31, 2013 (1.3 )% 2014 Three months ended March 31, 2014 (4.7 )% Three months ended June 30, 2014 (4.5 )% The comparable club revenue declines experienced since 2013 are primarily due to the impact of membership declines as well as decreases in ancillary club revenues. We experienced an overall member loss of 13,000 during 2013 and another 8,000 loss in the six months ended June 30, 2014. Comparable club revenue decreased 4.5% in the three months ended June 30, 2014 as compared to the same prior-year period.

19 -------------------------------------------------------------------------------- Table of Contents Results of Operations The following table sets forth certain operating data as a percentage of revenue for the periods indicated: Three Months Ended Six Months Ended June 30, June 30, 2014 2013 2014 2013 Revenue 100.0 % 100.0 % 100.0 % 100.0 % Operating expenses: Payroll and related 38.7 36.7 38.6 37.0 Club operating 42.0 36.7 42.4 36.9 General and administrative 6.5 5.8 6.8 5.7 Depreciation and amortization 10.2 10.3 10.2 10.3 Insurance recovery related to damaged property - (2.1 ) - (1.1 ) Impairment of fixed assets 0.8 0.1 1.9 0.1 Impairment of goodwill - - 0.1 - 98.2 87.5 100.0 88.9 Operating income (loss) 1.8 12.5 - 11.1 Interest expense 4.1 4.5 4.1 4.5 Equity in the earnings of investees and rental income (0.6 ) (0.5 ) (0.6 ) (0.5 ) (Loss) income before provision for corporate income taxes (1.7 ) 8.5 (3.5 ) 7.1 (Benefit) provision for corporate income taxes (0.9 ) 3.3 (1.6 ) 2.7 Net (loss) income (0.8 )% 5.2 % (1.9 )% 4.4 % Revenue (in thousands) was comprised of the following for the periods indicated: Three Months Ended June 30, 2014 2013 Revenue % Revenue Revenue % Revenue % Variance Membership dues $ 87,558 75.7 % $ 90,882 75.7 % (3.7 )% Joining fees 2,985 2.6 3,823 3.1 (21.9 ) Membership revenue 90,543 78.3 94,705 78.8 (4.4 ) Personal training revenue 18,244 15.8 17,615 14.7 3.6 Other ancillary club revenue (1) 5,377 4.6 6,474 5.4 (16.9 ) Ancillary club revenue 23,621 20.4 24,089 20.1 (1.9 ) Fees and other revenue (2) 1,533 1.3 1,318 1.1 16.3 Total revenue $ 115,697 100.0 % $ 120,112 100.0 % (3.7 )% (1) Other ancillary club revenue primarily consists of Small Group Training, Sports Clubs for Kids, and racquet sports.

(2) Fees and other revenue primarily consist of rental income, marketing revenue and management fees.

Revenue decreased 3.7% in the three months ended June 30, 2014 compared to the same prior-year period, as a result of decreases in both membership revenue and ancillary club revenue. For the three months ended June 30, 2014 compared to the same prior-year period, revenue decreased approximately $5.7 million at our clubs opened or acquired prior to June 30, 2012 and $429,000 at clubs that closed subsequent to June 30, 2012. These decreases were partially offset by a $1.8 million increase in revenue from our clubs that were opened or acquired subsequent to June 30, 2012.

Membership dues revenue decreased $3.3 million, or 3.7%, in the three months ended June 30, 2014 compared to the same prior-year period primarily due to a decline in memberships.

20 -------------------------------------------------------------------------------- Table of Contents Joining fees revenue decreased $838,000, or 21.9%, in the three months ended June 30, 2014 compared to the same prior-year period, primarily reflecting a decline in membership sales beginning in 2013. The decrease was partially offset by the effect of the lower estimated average membership life of 22 months during the three months ended June 30, 2014 compared to 24 months during the three months ended June 30, 2013. The lower amortizable life in the current year period resulted in higher joining fees revenue recognition as joining fees were amortized over a shorter estimated average membership life.

Personal training revenue increased $629,000, or 3.6%, in the three months ended June 30, 2014 compared to the same prior-year period, driven by increased pricing on our multi-session personal training membership products as well as increased interest in those products.

Other ancillary club revenue decreased $1.1 million, or 16.9%, in the three months ended June 30, 2014 compared to the same prior-year period primarily driven by a decline in revenue from our Small Group Training classes and Sports Clubs for Kids programs.

Comparable club revenue decreased 4.5% in the three months ended June 30, 2014 as compared to the same prior-year period. Memberships at our comparable clubs were down 2.9%, the combined effect of ancillary club revenue, joining fees and other revenue were down 1.3%, and the price of our dues and fees were down 0.3%.

Operating expenses (in thousands) were comprised of the following for the periods indicated: Three Months Ended June 30, 2014 2013 % Variance Payroll and related $ 44,762 $ 44,005 1.7 % Club operating 48,618 44,116 10.2 General and administrative 7,506 6,951 8.0 Depreciation and amortization 11,853 12,411 (4.5 ) Insurance recovery related to damaged property - (2,500 ) (100.0 ) Impairment of fixed assets 890 128 595.3 Operating expenses $ 113,629 $ 105,111 8.1 % Operating expenses for the three months ended June 30, 2014 increased $8.5 million, or 8.1%, compared to the same prior-year period. The total months of club operation increased 1.3% for the three months ended June 30, 2014 from the same prior-year period. Excluding the $2.5 million of insurance proceeds received during the three months ended June 30, 2013 in connection with property damaged by Hurricane Sandy, operating expenses increased $6.0 million, or 5.6% primarily due to the following factors: Payroll and related. Payroll and related expenses increased $757,000, or 1.7%, in the three months ended June 30, 2014 compared to the same prior-year period, primarily reflecting annual merit increases and increases in employment levels due to the acquisition of clubs in 2013. As a percentage of total revenue, payroll and related expenses increased to 38.7% in the three months ended June 30, 2014 from 36.7% in the three months ended June 30, 2013.

Club operating. Club operating expenses increased $4.5 million, or 10.2%, in the three months ended June 30, 2014 compared to the same prior-year period. This increase was principally attributable to the following: • Rent and occupancy expenses increased $2.9 million in the three months ended June 30, 2014 compared to the same period in the prior year. This increase included $1.3 million related to the acquisition and opening of new clubs in 2013 and the three months ended June 30, 2014, as well as three additional clubs scheduled to open in the second half of 2014 where the lease periods have commenced. Rent and occupancy expenses also increased $1.3 million at our existing clubs. The current year increase was also driven by the decrease in the prior-year period at one location for $231,000 from the reduction of rental space, including the benefit from unwinding of the deferred rent related to that space and $213,000 related to amounts received from one of our landlords in the prior-year period in return for exiting the space prior to the lease termination date.

• Utilities expense increased $883,000 in the three months ended June 30, 2014 compared to the same period in the prior year principally due to higher energy prices and higher utilities consumption from the increased number of clubs under operations.

21 -------------------------------------------------------------------------------- Table of Contents • Repair and maintenance increased $309,000 in the three months ended June 30, 2014 compared to the same prior-year period, reflecting an increase in overall club maintenance, in particular, repairs of heating, ventilation and air conditioning system.

In part as a result of the above, as a percentage of total revenue, club operating expenses increased to 42.0% in the three months ended June 30, 2014 from 36.7% in the three months ended June 30, 2013.

General and administrative. General and administrative expenses increased $555,000, or 8.0%, in the three months ended June 30, 2014 compared to the same period last year. As a percentage of total revenue, general and administrative expenses increased to 6.5% in the three months ended June 30, 2014 from 5.8% in the three months ended June 30, 2013. This increase was primarily due to increases in licensing fees related to the implementation of our new club operating system, and higher legal and consulting fees.

Depreciation and amortization. In the three months ended June 30, 2014 compared to the same period last year, depreciation and amortization expense decreased $558,000, or 4.5%, resulting from certain fixed asset write-offs in the last half of 2013.

Impairment of fixed assets. In the three months ended June 30, 2014, we reviewed our club portfolio and established plans to close approximately 5% of our clubs, which we believe are lower performing, by the end of 2014, in an effort to consolidate a portion of these members into other existing clubs. Since we have decided to close these clubs before their lease expiration date, these clubs were tested for impairment and an impairment loss of $734,000 was recorded at three of these clubs. In the three months ended June 30, 2014, we tested 19 additional clubs which are experiencing decreased profitability and sales levels below expectations and recorded an impairment loss of $156,000 on leasehold improvements and furniture and fixtures at three of these clubs. During the three months ended June 30, 2013, we recorded an impairment loss of $128,000 on fixed assets at one underperforming club. The remaining 16 underperforming clubs have an aggregate of $27.6 million of net leasehold improvements and furniture and fixtures remaining as of June 30, 2014. We expect our revised pricing and marketing strategy for suburban clubs to be applied to 11 of the 16 clubs. To the extent these clubs do not perform as expected, we may have additional impairment charges in the future.

Interest expense Interest expense decreased $738,000, or 13.6%, in the three months ended June 30, 2014 compared to the same period last year. This decrease in interest expense was primarily due to lower interest rates resulting from the November 15, 2013 refinancing, which were lower by approximately 125 basis points on the non-hedged debt principal and 80 basis points on the hedged debt principal.

(Benefit) Provision for Corporate Income Taxes We have determined our income tax (benefit) provision for the three months ended June 30, 2014 on a discrete basis. The potential impact of fluctuations in our forecast may have a significant impact on the estimated annual effective tax rate. Accordingly, we continue to calculate our effective tax rate discretely based on pre-tax results for the three months ended June 30, 2014.

We recorded an income tax benefit of $1.1 million and an income tax provision of $4.0 million for the three months ended June 30, 2014 and 2013, respectively, reflecting an effective tax rate of (54%) and 39%, respectively. The effective tax rates for the three month period ended June 30, 2014 and 2013 were favorably impacted by tax benefits derived from the captive insurance arrangement by approximately 13% and 4%, respectively. As of June 30, 2014, we had $13.3 million of unrecognized tax benefits. It is reasonably possible that we could realize $1.2 million of unrecognized tax benefits in the next twelve months since the income tax returns may no longer be subject to audit in 2014.

22-------------------------------------------------------------------------------- Table of Contents Revenue (in thousands) was comprised of the following for the periods indicated: Six Months Ended June 30, 2014 2013 Revenue % Revenue Revenue % Revenue % Variance Membership dues $ 176,194 76.1 % $ 181,624 75.9 % (3.0 )% Joining fees 6,194 2.6 7,648 3.2 (19.0 ) Membership revenue 182,388 78.7 189,272 79.1 (3.6 ) Personal training revenue 35,154 15.2 34,045 14.2 3.3 Other ancillary club revenue (1) 11,102 4.8 13,612 5.7 (18.4 ) Ancillary club revenue 46,256 20.0 47,657 19.9 (2.9 ) Fees and other revenue (2) 2,956 1.3 2,347 1.0 25.9 Total revenue $ 231,600 100.0 % $ 239,276 100.0 % (3.2 )% (1) Other ancillary club revenue primarily consists of Small Group Training, Sports Clubs for Kids, and racquet sports.

(2) Fees and other revenue primarily consist of rental income, marketing revenue and management fees.

Revenue decreased 3.2% in the six months ended June 30, 2014 compared to the same prior-year period, as a result of decreases in both membership revenue and ancillary club revenue. For the six months ended June 30, 2014 compared to the same prior-year period, revenue decreased approximately $10.7 million at our clubs opened or acquired prior to June 30, 2012 and $1.1 million at clubs that closed subsequent to June 30, 2012. These decreases were partially offset by a $4.1 million increase in revenue from our clubs that were opened or acquired subsequent to June 30, 2012.

Membership dues revenue decreased $5.4 million, or 3.0%, in the six months ended June 30, 2014 compared to the same period last year primarily due to a decline in memberships.

Joining fees revenue decreased $1.5 million, or 19.0%, in the six months ended June 30, 2014 compared to the same prior-year period, primarily reflecting a decline in membership sales. The decrease was partially offset by the effect of the lower estimated average membership life of 22 months during the six months ended June 30, 2014, versus 25 months and 24 months for the three month periods ended March 31, 2013 and June 30, 2013, respectively. The lower amortizable life in the current year period resulted in higher joining fees revenue recognition as joining fees were amortized over a shorter estimated average membership life.

Personal training revenue increased $1.1 million, or 3.3%, in the six months ended June 30, 2014 compared to the same prior-year period, driven by increased pricing on our multi-session personal training membership products as well as increased interest in those products.

Other ancillary club revenue decreased $2.5 million, or 18.4%, in the six months ended June 30, 2014 compared to the same period last year driven primarily by a decline in revenue from our Sports Clubs for Kids programs and Small Group Training.

Comparable club revenue decreased 4.6% for the six months ended June 30, 2014 as compared to the same prior-year period. Memberships at our comparable clubs were down 3.1%, the combined effect of ancillary club revenue, joining fees and other revenue were down 1.2%, and the price of our dues and fees were down 0.3%.

23-------------------------------------------------------------------------------- Table of Contents Operating expenses (in thousands) were comprised of the following for the periods indicated: Six Months Ended June 30, 2014 2013 % Variance Payroll and related $ 89,335 $ 88,553 0.9 % Club operating 98,213 88,316 11.2 General and administrative 15,787 13,740 14.9 Depreciation and amortization 23,651 24,559 (3.7 ) Insurance recovery related to damaged property - (2,500 ) (100.0 ) Impairment of fixed assets 4,513 128 3,425.8 Impairment of goodwill 137 - N/A Operating expenses $ 231,636 $ 212,796 8.9 % Operating expenses for the six months ended June 30, 2014 increased $18.8 million, or 8.9%, compared to the same prior-year period. The total months of club operation increased 2.0% for the six months ended June 30, 2014 compared to the same period last year. Excluding the $2.5 million of insurance proceeds received during the six months ended June 30, 2013 in connection with property damaged by Hurricane Sandy, operating expenses increased $16.3 million, or 7.6% primarily due to the following factors: Payroll and related. Payroll and related expenses increased $782,000, or 0.9% in the six months ended June 30, 2014 compared to the same prior-year period, primarily due to merit increases and increases in employment levels due to the acquisition of clubs in 2013. As a percentage of total revenue, payroll and related expenses increased to 38.6% in the six months ended June 30, 2014 from 37.0% in the six months ended June 30, 2013.

Club operating. Club operating expenses increased $9.9 million, or 11.2% in the six months ended June 30, 2014 compared to the same prior-year period. This increase was principally attributable to the following: • Rent and occupancy expenses increased $5.6 million in the six months ended June 30, 2014 compared to the same period in the prior year. This increase included $2.6 million related to the acquisition and opening of new clubs in 2013 and the second quarter of 2014, as well as three additional clubs scheduled to open in the second half of 2014 where the lease periods have commenced. Rent and occupancy expenses also increased $1.8 million at our existing clubs. The current year increase was also driven by the decrease in the prior-year period at one location for $247,000 primarily from the reduction of rental space, including the unwinding of the deferred rent related to that space and $986,000 related to two early lease terminations in the prior-year period and the unwinding of the remaining deferred rent at those locations.

• Utilities expense increased $2.8 million in the six months ended June 30, 2014 compared to the same period in the prior year principally due to higher energy prices. Energy prices were negatively impacted by the severe cold experienced in our markets during the six months ended June 30, 2014.

In part as a result of the above, as a percentage of total revenue, club operating expenses increased to 42.4% in the six months ended June 30, 2014 from 36.9% in the six months ended June 30, 2013.

General and administrative. General and administrative expenses increased $2.0 million, or 14.9% in the six months ended June 30, 2014 compared to the same prior-year period. As a percentage of total revenue, general and administrative expenses increased to 6.8% in the six months ended June 30, 2014 from 5.7% in the six months ended June 30, 2013. This increase was primarily due to increases in licensing fees related to the implementation of our new club operating system and general liability insurance expense. We also experienced increases in audit and tax fees. These increases were offset by a decrease in legal fees as well as club acquisition related fees incurred during the six months ended June 30, 2013.

Depreciation and amortization. In the six months ended June 30, 2014 compared to the same period last year, depreciation and amortization expense decreased $908,000, or 3.7% , resulting from certain fixed asset write-offs in the last half of 2013.

Impairment of fixed assets. For the six months ended June 30, 2014, we recorded an impairment loss of $4.5 million on fixed assets related to five underperforming clubs and three clubs which are closing. During the six months ended June 30, 2013, we recorded an impairment loss of $128,000 on fixed assets at one underperforming club. The remaining 16 24-------------------------------------------------------------------------------- Table of Contents underperforming clubs have an aggregate of $27.6 million of net leasehold improvements and furniture and fixtures remaining as of June 30, 2014. We expect our revised pricing and marketing strategy for suburban clubs to be applied to 11 of the 16 clubs. To the extent these clubs do not perform as expected, we may have additional impairment charges in the future.

Impairment of goodwill. For the six months ended June 30, 2014, we recorded an impairment loss of $137,000 on goodwill at one of our outlier clubs as a result of our annual goodwill impairment test as of February 28, 2014. The impairment loss is included as a component of operating expenses in a separate line on the condensed consolidated statements of operations. We did not have goodwill impairment in the six months ended June 30, 2013.

Interest expense Interest expense decreased $1.4 million, or 12.8%, in the six months ended June 30, 2014 compared to the same period last year. This decrease in interest expense was primarily due to lower interest rates resulting from the November 15, 2013 refinancing, which were lower by approximately 125 basis points on the non-hedged debt principal and 80 basis points on the hedged debt principal.

(Benefit) Provision for Corporate Income Taxes We have determined our income tax benefit for the six months ended June 30, 2014 on a discrete basis. The potential impact of fluctuations in our forecast may have a significant impact on the estimated annual effective tax rate.

Accordingly, the Company calculated its effective tax rate discretely based on pre-tax results through the six months ended June 30, 2014.

We recorded a benefit for corporate income taxes of $3.8 million and a provision of $6.5 million for the six months ended June 30, 2014 and 2013, respectively, reflecting an effective tax rate of (46%) and 39%, respectively. The effective tax rates for the six month period ended June 30, 2014 and 2013 were favorably impacted by tax benefits derived from the captive insurance arrangement by approximately 7% and 4%, respectively. As of June 30, 2014, we had $13.3 million of unrecognized tax benefits. It is reasonably possible that we could realize $1.2 million of unrecognized tax benefits in the next twelve months since the income tax returns may no longer be subject to audit in 2014.

Liquidity and Capital Resources Historically, we have satisfied our liquidity needs through cash generated from operations and various borrowing arrangements. Principal liquidity needs have included the acquisition and development of new clubs, debt service requirements, and other capital expenditures necessary to upgrade, expand and renovate existing clubs. In December 2012, we also paid a special cash dividend of $3.00 per share and in December 2013, March 2014 and June 2014, we paid a cash dividend of $0.16 per share. Any determination to pay future dividends will be made by the board of directors and will take into account such matters as cash on hand, general economic and business conditions, our strategic plans, our financial results and condition, contractual, legal and regulatory restrictions on the payment of dividends by us and our subsidiaries and such other factors as our board of directors may consider to be relevant. We believe that our existing cash and cash equivalents, cash generated from operations and our existing credit facility will be sufficient to fund capital expenditures, working capital needs and other liquidity requirements associated with our operations through at least the next 12 months.

Operating Activities. Net cash provided by operating activities for the six months ended June 30, 2014 decreased $20.1 million compared to the same period last year. This decrease was primarily driven by the decrease in overall earnings.

Investing Activities. Net cash used in investing activities decreased $1.6 million in the six months ended June 30, 2014 compared to the same prior-year period. The decrease is primarily due to a deposit of $5.0 million received in connection with the pending sale of our 86th Street building in Manhattan during the six months ended June 30, 2014, partially offset by the increased activity in the building of new clubs and new BFX Studio locations during the six months ended June 30, 2014. Investing activities in the six months ended June 30, 2014 and 2013 both consisted of capital expenditures for expanding and remodeling existing clubs, and the purchase of new fitness equipment. Investing activities in the six months ended June 30, 2013 also consisted of $2.9 million of net cash paid for the acquisition of clubs and insurance proceeds of $2.5 million related to insurance recoveries related to property damages from Hurricane Sandy.

For the year ending December 31, 2014, we currently plan to invest $45.0 million to $50.0 million in capital expenditures compared to $33.8 million of capital expenditures in 2013, which included acquisition purchase prices. The 2014 amount includes approximately $20.0 million to $22.0 million related to 2014 and 2015 club openings, including those under our new BFX Studio concept. Total capital expenditures also includes approximately $18.0 million to $20.0 million to 25 -------------------------------------------------------------------------------- Table of Contents continue enhancing or upgrading existing clubs and approximately $4.0 million to $4.5 million principally related to major renovations at clubs with recent lease renewals. We also expect to invest approximately $3.0 million to $3.2 million to continue to enhance our management information and communication systems. We expect these capital expenditures to be funded by cash flow provided by operations, available cash on hand and the after-tax proceeds from such sale. If the after-tax proceeds from the sale of the East 86th Street Property are not reinvested in our business, we may be required to pay such amounts to pay down our outstanding debt, as provided under the terms of our 2013 Senior Credit Facility.

Financing Activities. Net cash used in financing activities for the six months ended June 30, 2014 was $9.2 million compared to net cash provided by financing activities of $236,000 for the same prior-year period. In the six months ended June 30, 2014, we made a principal payment of $1.6 million on the 2013 Term Loan Facility and paid cash dividends to common stockholders of $7.7 million.

In the six months ended June 30, 2013, we were not required to make the regularly scheduled quarterly principal payments pursuant to our term loan facility as a result of a voluntary prepayment made in August 2012 of $15.0 million. In addition, the second amendment to our credit facility in November 2012 waived the requirement to pay the excess cash flow payment that was due on March 31, 2013. There were no dividends paid in the six months ended June 30, 2013.

As of June 30, 2014, we had $77.4 million of cash and cash equivalents.

Financial instruments that potentially subject us to concentrations of credit risk consist of cash and cash equivalents and the interest rate swap. Although we deposit our cash with more than one financial institution, as of June 30, 2014 approximately $51.5 million was held at one financial institution. We have not experienced any losses on cash and cash equivalent accounts to date and we do not believe that, based on the credit ratings of these financial institutions, we are exposed to any significant credit risk related to cash at this time.

As of June 30, 2014, our total gross consolidated debt was $323.4 million. This substantial amount of debt could have significant consequences, including the following: • making it more difficult to satisfy our obligations, including with respect to our outstanding indebtedness; • increasing our vulnerability to general adverse economic conditions; • limiting our ability to obtain additional financing to fund future working capital, capital expenditures, acquisitions of new clubs and other general corporate requirements; • requiring cash flow from operations for the payment of interest on our debt, which is variable on our 2013 Revolving Loan Facility and partially variable on our 2013 Term Loan Facility, and/or principal pursuant to excess cash flow requirements and reducing our ability to use our cash flow to fund working capital, capital expenditures, acquisitions of new clubs and general corporate requirements; and • limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate.

These limitations and consequences may place us at a competitive disadvantage to other less-leveraged competitors.

We believe that we have, or will be able to, obtain or generate sufficient funds to finance our current operating and growth plans through the next 12 months.

Any material acceleration or expansion of our plans through newly constructed clubs or acquisitions (to the extent such acquisitions include cash payments) may require us to pursue additional sources of financing. There can be no assurance that such financing will be available, or that it will be available on acceptable terms.

2013 Senior Credit Facility On November 15, 2013, TSI, LLC, an indirect, wholly-owned subsidiary, entered into a $370.0 million senior secured credit facility ("2013 Senior Credit Facility"), among TSI, LLC, TSI Holdings II, LLC, a newly-formed, wholly-owned subsidiary of the Company ("Holdings II"), as a Guarantor, the lenders party thereto, Deutsche Bank AG, as administrative agent, and Keybank National Association, as syndication agent. The 2013 Senior Credit Facility consists of a $325.0 million term loan facility maturing on November 15, 2020 ("2013 Term Loan Facility") and a $45.0 million revolving loan facility maturing on November 15, 2018 ("2013 Revolving Loan Facility"). Proceeds from the 2013 Term Loan Facility of $323.4 million was issued, net of an original issue discount ("OID") of 0.5%, or $1.6 million. Debt issuance costs recorded in connection with the 2013 Senior Credit Facility was $5.1 million and will be amortized as interest expense and are included in other assets in the accompanying condensed consolidated balance sheets. The Company also recorded additional debt discount of $4.4 million related to creditor fees. The proceeds from the 2013 Term Loan Facility were used to pay off 26 -------------------------------------------------------------------------------- Table of Contents amounts outstanding under the Company's previously outstanding long-term debt facility originally entered into on May 11, 2011 (as amended from time to time), and to pay related fees and expenses. None of the revolving loan facility was drawn upon as of the closing date on November 15, 2013, but loans under the 2013 Revolving Loan Facility may be drawn from time to time pursuant to the terms of the 2013 Senior Credit Facility. The borrowings under the 2013 Senior Credit Facility are guaranteed and secured by assets and pledges of capital stock by Holdings II, TSI, LLC, and, subject to certain customary exceptions, the wholly-owned domestic subsidiaries of TSI, LLC.

Borrowings under the 2013 Term Loan Facility and the 2013 Revolving Loan Facility, at TSI, LLC's option, bear interest at either the administrative agent's base rate plus 2.5% or a LIBOR rate adjusted for certain additional costs (the "Eurodollar Rate") plus 3.5%, each as defined in the 2013 Senior Credit Facility. With respect to the outstanding term loans, the Eurodollar Rate has a floor of 1.00% and the base rate has a floor of 2.00%. Commencing with the last business day of the quarter ended March 31, 2014, TSI, LLC is required to pay 0.25% of the principal amount of the term loans each quarter, which may be reduced by voluntary prepayments. As of June 30, 2014, TSI LLC has made a total of $1.6 million in principal payments on the 2013 Term Loan Facility.

The terms of the 2013 Senior Credit Facility provide for a financial covenant in the situation where the utilization of the revolving loan commitments (other than letters of credit up to $5.5 million at any time outstanding) exceeds 25% of the commitment. In such event, TSI, LLC is required to maintain a total leverage ratio, as defined in the 2013 Senior Credit Facility, of no greater than 4.50:1.00. Other than $3.0 million of letters of credit, we did not have any amounts utilized on the 2013 Revolving Loan Facility and therefore we are not subject to this financial covenant as of June 30, 2014. The 2013 Senior Credit Facility also contains certain affirmative and negative covenants, including covenants that may limit or restrict TSI, LLC and Holdings II's ability to, among other things, incur indebtedness and other liabilities; create liens; merge or consolidate; dispose of assets; make investments; pay dividends and make payments to shareholders; make payments on certain indebtedness; and enter into sale leaseback transactions, in each case, subject to certain qualifications and exceptions. The 2013 Senior Credit Facility also includes customary events of default (including non-compliance with the covenants or other terms of the 2013 Senior Credit Facility) which may allow the lenders to terminate the commitments under the 2013 Revolving Loan Facility and declare all outstanding term loans and revolving loans immediately due and payable and enforce its rights as a secured creditor.

TSI, LLC may prepay the 2013 Term Loan Facility and 2013 Revolving Loan Facility without premium or penalty in accordance with the 2013 Senior Credit Facility.

Mandatory prepayments are required relating to certain asset sales, insurance recovery and incurrence of certain other debt and commencing in 2015 in certain circumstances relating to excess cash flow (as defined) for the prior fiscal year, as described below, in excess of certain expenditures. The 2013 Senior Credit Facility contains provisions that require excess cash flow payments, as defined, to be applied against outstanding 2013 Term Loan Facility balances. The excess cash flow is calculated annually commencing with the fiscal year ending December 31, 2014 and paid 95 days after the fiscal year end. The applicable excess cash flow repayment percentage is applied to the excess cash flow when determining the excess cash flow payment. Earnings, changes in working capital and capital expenditure levels all impact the determination of any excess cash flow. The applicable excess cash flow repayment percentage is 50% when the total leverage ratio, as defined in the 2013 Senior Credit Facility, exceeds 2.50:1.00; 25% when the total leverage ratio is greater than 2.00:1.00 but less than or equal to 2.50:1.00 and 0% when the total leverage ratio is less than or equal to 2.00:1.00. Our first excess cash flow payment is due in April 2015, if applicable. Based on our unit growth projection and increased capital expenditures related to the building of new clubs and new BFX Studio locations, together with our operating forecast, we do not expect there will be an excess cash flow payment required at that time.

As of June 30, 2014, the 2013 Term Loan Facility has a gross principal balance of $323.4 million and a balance of $313.9 million net of unamortized debt discount of $9.4 million which is comprised of the unamortized portions of the OID recorded in connection with the May 11, 2011 debt issuance and the unamortized balance of the additional debt discounts recorded in connection with the First Amendment and Second Amendment to the 2011 Senior Credit Facility. The unamortized debt discount balance is recorded as a contra-liability to long-term debt on the accompanying condensed consolidated balance sheet and is being amortized as interest expense using the effective interest method. As of June 30, 2014, the unamortized balance of debt issuance costs of $3.8 million is being amortized as interest expense, and is included in other assets in the accompanying condensed consolidated balance sheets.

As of June 30, 2014, there were no outstanding 2013 Revolving Loan Facility borrowings and outstanding letters of credit issued totaled $3.0 million. The unutilized portion of the 2013 Revolving Loan Facility as of June 30, 2014 was $42.0 million.

27 -------------------------------------------------------------------------------- Table of Contents Repayment of 2011 Senior Credit Facility TSI, LLC's previously outstanding senior secured credit facility was originally entered into on May 11, 2011 and consisted of a $350.0 million senior secured credit facility ("2011 Senior Credit Facility") comprised of a $300.0 million term loan facility ("2011 Term Loan Facility") scheduled to mature on May 11, 2018 and a $50.0 million revolving loan facility scheduled to mature on May 11, 2016 ("2011 Revolving Loan Facility").

Contemporaneously with entry into the 2013 Senior Credit Facility, TSI, LLC repaid the outstanding principal amount of the 2011 Term Loan Facility of $315.7 million. The 2011 Term Loan Facility was set to expire on May 11, 2018. There were no outstanding amounts under the 2011 Revolving Loan Facility as of November 15, 2013, the date of the initial borrowing under the 2013 Senior Credit Facility. The 2011 Term Loan Facility was repaid at face value of $315.7 million plus accrued and unpaid interest of $807,000 and letter of credit fees and commitment fees of $67,000. The total cash paid in connection with this repayment was $316.6 million as of November 15, 2013 with no early repayment penalty. The Company determined that the 2013 Senior Credit Facility was not substantially different than the 2011 Senior Credit Facility for certain lenders based on the less than 10% difference in cash flows of the respective debt instruments. A portion of the transaction was therefore accounted for as a modification of the 2011 Senior Credit Facility and a portion was accounted for as an extinguishment. As of November 15, 2013, the Company recorded loss on extinguishment of debt of approximately $750,000, representing the write-off of the remaining unamortized debt costs and debt discount related to the portion of the 2011 Senior Credit Facility that was accounted for as an extinguishment, and was included in loss on extinguishment of debt in the consolidated statement of operations for the year ended December 31, 2013 in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2013.

Financial Instruments In our normal operations, we are exposed to market risks relating to fluctuations in interest rates. In order to minimize the possible negative impact of such fluctuations on our cash flows we may enter into derivative financial instruments ("derivatives"), such as interest-rate swaps. Any instruments are not entered into for trading purposes and we only use commonly traded instruments. Currently, we have used derivatives solely relating to the variability of cash flows from interest rate fluctuations.

We originally entered into our interest rate swap arrangement on July 13, 2011 in connection with the 2011 Senior Credit Facility. We entered into an interest rate swap arrangement which effectively converted $150.0 million of our variable-rate debt based on a one-month Eurodollar rate to a fixed rate of 1.983%, or a total fixed rate of 7.483%, on this $150.0 million when including the applicable 5.50% margin that was in effect under the 2011 Senior Credit Facility at that time. In August 2012, we amended the terms of the 2011 Senior Credit Facility to, among other things, reduce the applicable margin on Eurodollar rate loans from 5.50% to 4.50% and reduce the interest rate floor on Eurodollar rate loans from 1.50% to 1.25%. In conjunction with the First Amendment to the 2011 Senior Credit Facility in August 2012, the interest rate swap arrangement was amended to reduce the one-month Eurodollar fixed rate from 1.983% to 1.783%, or a total fixed rate of 6.283% when including the applicable 4.50% margin on Eurodollar rate loans in effect under the 2011 Senior Credit Facility at that time. On November 14, 2012, we further amended the terms of the 2011 Senior Credit Facility to, among other things, allow for the borrowing of a $60.0 million incremental term loan. In connection with the Second Amendment to the 2011 Credit Facility, we further amended the interest rate swap to increase the notional amount to $160.0 million and extended the maturity of the swap to from July 13, 2014 to May 13, 2015. In addition, the one-month Eurodollar fixed rate was lowered from 1.783% to 1.693%, or a total of 6.193% when including the applicable 4.50% margin on Eurodollar rate loans in effect under the 2011 Senior Credit Facility at that time. In connection with entering into the 2013 Senior Credit Facility, we amended and restated the interest rate swap arrangement it initially entered into on July 13, 2011 (and amended in August 2012 and November 2012). Effective as of November 15, 2013, the closing date of the 2013 Senior Credit Facility, the interest rate swap will continue to have a notional amount of $160.0 million and will mature on May 15, 2018. The swap effectively converts $160.0 million of the $325.0 million total variable-rate debt under the 2013 Senior Credit Facility to a fixed rate of 5.384%, when including the applicable 3.50% margin. As permitted by FASB Accounting Standards Codification ("ASC") 815, Derivatives and Hedging, we have designated this swap as a cash flow hedge, the effects of which have been reflected in our condensed consolidated financial statements as of and for the three and six months ended June 30, 2014 and 2013.

The objective of this hedge is to manage the variability of cash flows in the interest payments related to the portion of the variable-rate debt designated as being hedged.

When our derivative instrument was executed, hedge accounting was deemed appropriate and it was designated as a cash flow hedge at inception with re-designation being permitted under ASC 815, Derivatives and Hedging. Interest rate swaps are designated as cash flow hedges for accounting purposes since they are being used to transform variable interest rate exposure to fixed interest rate exposure on a recognized liability (debt). On an ongoing basis, we perform a quarterly assessment of the hedge effectiveness of the hedge relationship and measure and recognize any hedge ineffectiveness in the condensed consolidated statements of operations. For the three and six months ended June 30, 2014, hedge ineffectiveness was evaluated using the hypothetical derivative method.

There was no hedge ineffectiveness for the three and six months ended June 30, 2014 and 2013.

28 -------------------------------------------------------------------------------- Table of Contents The counterparty to our derivatives is a major banking institution with a credit rating of investment grade or better and no collateral is required, and there are no significant risk concentrations. We believe the risk of incurring losses on derivative contracts related to credit risk is unlikely.

Contractual Obligations Our aggregate long-term debt and operating lease obligations as of June 30, 2014 were as follows: Payments Due by Period (in thousands) Less than More than Contractual Obligations (4)(5) Total 1 Year 1-3 Years 3-5 Years 5 Years Long-term debt (1 ) $ 323,375 $ 3,250 $ 6,500 $ 6,500 $ 307,125 Interest payments on long-term debt (2 ) 96,496 16,126 31,808 29,368 19,194 Operating lease obligations (3 ) 664,793 91,769 172,517 140,497 260,010 Total contractual obligations $ 1,084,664 $ 111,145 $ 210,825 $ 176,365 $ 586,329 Notes: (1) Principal amounts paid each year may increase if annual excess cash flow amounts are required (as described above). The first excess cash flow payment is due in April 2015, if applicable. This table assumes no payment of excess cash flow in April 2015.

(2) Based on interest rates pursuant to the 2013 Term Loan Facility and the interest swap agreement as of June 30, 2014.

(3) Operating lease obligations include base rent only. Certain leases provide for additional rent based on real estate taxes, common area maintenance and defined amounts based on our operating results.

(4) The table above does not include any future obligations that would arise in connection with leases at East 86th Street, New York following the sale of that property which, subject to closing conditions, is expected to close on or before September 11, 2014.

(5) The table above does not reflect charges related to planned club closures.

The following long-term liabilities included on the condensed consolidated balance sheet are excluded from the table above: income taxes (including uncertain tax positions or benefits), insurance accruals and other accruals. We are unable to estimate the timing of payments for these items.

Working Capital We had working capital of $25.1 million and $27.8 million at June 30, 2014 and December 31, 2013, respectively. Major components of our working capital on the current assets side are cash and cash equivalents, accounts receivable, prepaid expenses and other current assets, and the current portion of deferred tax assets. As of June 30, 2014, these current assets more than offset the current liabilities, which consist of deferred revenues, accounts payable, accrued expenses (including, among others, accrued construction in progress and equipment, payroll and occupancy costs) and the current portion of long-term debt. The deferred revenue that is classified as a current liability relates to dues and services paid-in-full in advance and joining fees paid at the time of enrollment and totaled $39.3 million and $33.9 million at June 30, 2014 and December 31, 2013, respectively. Joining fees received are deferred and amortized over the estimated average membership life of a club member. Prepaid dues and fees for prepaid services are generally realized over a period of up to twelve months. In periods when we increase the number of clubs open and consequently increase the level of payments received in advance, we would expect to see increased deferred revenue balances. By contrast, any decrease in demand for our services or reductions in joining fees collected would have the effect of reducing deferred revenue balances, which would likely require us to rely more heavily on other sources of funding. In either case, a significant portion of the deferred revenue is not expected to constitute a liability that must be funded with cash. At the time a member joins our club, we incur enrollment costs, a portion of which are deferred over the estimated average membership life. These costs are recorded as a long-term asset and as such do not offset working capital. Should we record a working capital deficit in future periods, as in the past, we will fund such deficit using cash flows from operations and borrowings under our 2013 Senior Credit Facility. We believe that these sources will be sufficient to cover such deficit.

29-------------------------------------------------------------------------------- Table of Contents Recent Changes in or Recently Issued Accounting Pronouncements See Note 2 - Recent Accounting Pronouncements to the condensed consolidated financial statements in this Form 10-Q.

Use of Estimates and Critical Accounting Policies Fixed and intangible assets. Fixed assets are recorded at cost and depreciated on a straight-line basis over the estimated useful lives of the assets, which are 30 years for building and improvements, five years for club equipment, furniture, fixtures, flooring and computer equipment and three to five years for computer software. Leasehold improvements are amortized over the shorter of their estimated useful lives or the remaining period of the lease. Expenditures for maintenance and repairs are charged to operations as incurred. The cost and related accumulated depreciation, or amortization of assets retired or sold, are removed from the respective accounts and any gain or loss is recognized in operations. The costs related to developing web applications, developing web pages and installing developed applications on the web servers are capitalized and classified as computer software. Web site hosting fees and maintenance costs are expensed as incurred.

Long-lived assets, such as fixed assets and intangible assets are reviewed for impairment when events or circumstances indicate that the carrying value may not be recoverable. Our long-lived assets are grouped at the individual club level which is the lowest level for which there are identifiable cash flows. Estimated undiscounted expected future cash flows are used to determine if an asset group is impaired, in which case the asset's carrying value would be reduced to its fair value, calculated considering a combination of market participant approach and a cost approach. Projected cash flows are based on internal budgets and forecasts through the end of each respective lease. The most significant assumptions in those budgets and forecasts relate to estimated membership and ancillary revenue, attrition rates, estimated results related to new program launches and maintenance capital expenditures, which are generally estimated at approximately 3% to 5% of total revenue. Actual cash flows realized could differ from those estimated and could result in asset impairments in the future. See Note 8 - Fixed Asset Impairment to our condensed consolidated financial statements.

In the three months ended June 30, 2014, we also reviewed our club portfolio and established plans to close approximately 5% of our clubs, which we believe are lower performing, by the end of 2014, in an effort to consolidate a portion of these members into other existing clubs. Since we have decided to close these clubs before their lease expiration date, these clubs were tested for impairment and an impairment loss of $734,000 was recorded at three of these clubs. In the three months ended June 30, 2014, we tested 19 additional clubs which are experiencing decreased profitability and sales levels below expectations and recorded an impairment loss of $156,000 on leasehold improvements and furniture and fixtures at three of these clubs. In the six months ended June 30, 2014, we recorded a total of $4.5 million of impairment losses at eight clubs compared to an impairment loss of $128,000 at one club in the same prior-year period. The remaining 16 underperforming clubs have an aggregate of $27.6 million of net leasehold improvements and furniture and fixtures remaining as of June 30, 2014.

We expect our revised pricing and marketing strategy for suburban clubs to be applied to 11 of the 16 clubs. To the extent these clubs do not perform as expected, we may have additional impairment charges in the future.

Goodwill has been allocated to reporting units that closely reflect the regions served by our four trade names: New York Sports Clubs ("NYSC"), Boston Sports Clubs ("BSC"), Washington Sports Clubs ("WSC") and Philadelphia Sports Clubs ("PSC"), with certain more remote clubs that do not benefit from a regional cluster being considered single reporting units ("Outlier Clubs") and our three clubs located in Switzerland ("SSC"). The WSC and PSC regions do not have any goodwill as of June 30, 2014. The carrying value of goodwill was allocated to our reporting units pursuant to FASB guidance.

As of February 28, 2014 and February 28, 2013, we performed our annual impairment test of goodwill. As of February 28, 2014, we concluded that there would be no remaining implied value attributable to the Outlier Clubs. As a result of this test, we impaired $137,000 of goodwill associated with this reporting unit. We did not have a goodwill impairment charge in the NYSC, BSC and SSC regions.

We completed an interim evaluation of the goodwill by reporting unit due to the existence of a triggering event as of May 31, 2014. The determination as to whether a triggering event exists that would warrant an interim review of goodwill and whether a write-down of goodwill is necessary involves significant judgment based on short-term and long-term projections of the Company. Due to the significant decrease in market capitalization and a decline in our business outlook, we performed an interim impairment test as of May 31, 2014. There was no goodwill impairment as a result of this interim test.

30-------------------------------------------------------------------------------- Table of Contents The valuation of intangible assets requires assumptions and estimates of many critical factors, including revenue and market growth, operating cash flows and discount rates. We will continue to complete interim evaluations of the goodwill by reporting unit if a triggering event exists.

Deferred Income Taxes. As of June 30, 2014, the Company has net deferred tax assets of $34.5 million. The state net deferred tax asset balance as of June 30, 2014 is $23.4 million. Quarterly, the Company assesses the weight of all positive and negative evidence to determine whether the net deferred tax asset is realizable. The Company was profitable for the years ended December 31, 2013 and December 31, 2012. Although, there is a pre-tax loss for the six months ended June 30, 2014, the Company forecasts a profit (inclusive of the sale of the 86th East Street New York Property) for the full year and expects to be in a three year cumulative income position as of December 31, 2014 for both federal and certain state jurisdictions. In addition, the Company projects future taxable income sufficient to realize the deferred tax assets during the periods when the temporary tax deductible differences reverse. With the exception of the deductions related to our captive insurance company for state taxes, state taxable income has been and is projected to be the same as federal taxable income. Because the Company expects the captive insurance company to be discontinued beginning in 2015, the assessment of the realizability of the state deferred tax assets is consistent with the federal tax analysis above. The Company has state net operating loss carry-forwards which the Company believes will be realized within the available carry-forward period, except for a small state net operating loss carry-forward in Rhode Island due to the short carry-forward period in that state. Accordingly, the Company concluded that, with the exception of net operating loss carry-forward in Rhode Island, it is more likely than not that the deferred tax assets will be realized. If actual results do not meet the Company's forecasts and the Company incurs losses in 2014 and beyond, a valuation allowance against the deferred tax assets may be required in the future.

Forward-Looking Statements This Quarterly Report on Form 10-Q contains "forward-looking" statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including, without limitation, statements regarding our future expectations regarding the sale of the property located at East 86th Street, New York, future financial results and performance, potential sales revenue, legal contingencies and tax benefits and contingencies, future declarations and payments of dividends, and the existence of adverse litigation and other risks, uncertainties and factors set forth under Item 1A., entitled "Risk Factors", in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2013 and in our other reports and documents filed with the SEC. You can identify these forward-looking statements by the use of words such as "outlook", "believes", "expects", "potential", "continues", "may", "will", "should", "seeks", "approximately", "predicts", "intends", "plans", "estimates", "anticipates" or the negative version of these words or other comparable words.

These statements are subject to various risks and uncertainties, many of which are outside our control, including the level of market demand for our services, economic conditions affecting the Company's business, the geographic concentration of the Company's clubs, competitive pressure, the ability to achieve reductions in operating costs and to continue to integrate acquisitions, the ability to close the sale of the property located at East 86th Street, New York, environmental matters, the application of Federal and state tax laws and regulations, any security and privacy breaches involving customer data, the levels and terms of the Company's indebtedness, and other specific factors discussed herein and in other SEC filings by us (including our reports on Forms 10-K and 10-Q filed with the SEC). We believe that all forward-looking statements are based on reasonable assumptions when made; however, we caution that it is impossible to predict actual results or outcomes or the effects of risks, uncertainties or other factors on anticipated results or outcomes and that, accordingly, one should not place undue reliance on these statements.

Forward-looking statements speak only as of the date when made and we undertake no obligation to update these statements in light of subsequent events or developments. Actual results may differ materially from anticipated results or outcomes discussed in any forward-looking statement.

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